BoE preview: falling real wages remain sticking point

After yesterday's stronger-than-expected CPI print, investors were wondering how UK wages had fared and whether more of the Bank of England's Monetary Policy Committee members would vote for a rate rise on Thursday.

After yesterday's stronger-than-expected CPI print, investors were wondering how UK wages had fared and whether more of the Bank of England's Monetary Policy Committee members would vote for a rate rise on Thursday. We got the answer to one of those questions this morning as wages data disappointed, which actually implies that the BoE is likely to keep interest rates unchanged, most likely in a 7-2 vote, as widely expected. If this turns out to be the case, we may see a pause in the GBP rally after its big upsurge over the past several trading sessions.

According to the ONS, both the headline average earnings index and earnings excluding bonuses printed +2.1% in the three months to July compared to the same period last year. Both measures were weaker than expected and unchanged from June. However the employment situation continued to improve. The UK unemployment rate fell to 4.3% in the 3 months to July 2017, the lowest since 1975, as employment rose to 181,000 from 125,000 previously. Meanwhile jobless claims in August unexpectedly fell by 2,800 applications, which points to further improvement in the labour market.

The GBP/USD, which had hit the ground running earlier this morning, fell back relatively sharply on the back of the disappointing wages data, although the losses were contained as investors looked ahead to the Bank of England’s meeting tomorrow. Given the increase in inflation to 2.9% and the stagnant wage growth at 2.1%, real wages have fallen further which makes it extremely difficult for the BoE to make a decision on interest rates.

On the one hand, the Monetary Policy Committee cannot justify keeping interest rates at the current record low level of 0.25% for too long given the acceleration in inflation. Mark Carney and his MPC colleagues are fully aware of the risks to economy if they were to tighten monetary policy more aggressively when inflation is overcooked. Even if they think inflation will fall back in the coming months, and there are good reasons why this may well be the case, there is always that danger that prices may remain elevated or even rise further. After all, the impact of the past depreciation of sterling has not been entirely passed through to the consumer as up until now some of the higher import costs have been absorbed by producers.

But on the other hand, tightening policy too early and given the ongoing Brexit-related uncertainty may be more damaging to the economy at this critical time.

So, the most likely outcome is that the Bank of England will keep its policy unchanged not just at tomorrow’s meeting but probably in its subsequent meetings too until at least the end of this year. But any changes in the number of dissenters is what will drive the pound going forward. If we see more than 2 MPC members vote for a rate rise at this meeting then we could see the rally further accelerate in the GBP/USD and GBP crosses. Otherwise, a pause in the rally would be the most probable outcome heading into the second half of the week.

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